The Behavioral Economics of Groupon

I gotta admit, G and I have been totally out of the Groupon loop. But a company that turns down billions from Google and plans an IPO with an implied valuation in the $20B range deserves a bit more attention.

Other than “irrational exuberance,” what could go wrong? A reporter at the Christian Science Monitor seems to think that Groupon is facing an uphill challenge… due to behavioral economics. The gist of her assessment:

People don’t like products and services as well when they pay a discounted price for them… when we pay more for an item or service, we value it more.

She goes on to cite a study done by a group of resort properties that found that (based on comment cards), people who paid full price liked the stay better than those who got a steep discount. I am not sure what to make of this, but I can come up with all kinds of reasons that people who paid full price might have had a better time than those who got a steep discount (e.g., the former might be more likely to have traveled without their children, enjoyed nicer dinners, traveled first class) — and that leaves out the possibility that who fills out satisfaction cards might differ by income or other potential confounders.

The main insight from behavioral economics that I think she’s getting at is that people are really quite bad at attaching an absolute value to things. In those settings, we may be tempted to use price as a surrogate for quality, an effect that has been nicely demonstrated in wines, for example.

But you can have your cake and eat it too… or whatever the equivalent would be for burgers. My colleague Larry Zarin – who is a marketing genius and really drove Consumerology at Express Scripts – repeatedly reminds me of one of his favorite campaigns. In it, Carl’s Jr. advertised a “six dollar burger” for $3.95.

The idea? Consumers attach six dollars of value to the burger but pay much less.

Groupon does a nice job taking this same approach. Instead of focusing on the discount itself or the discounted price, they generally promote the pre- and post-discount prices. This probably has the effect of anchoring the value on the pre-discounted price. Instead of getting a smoothie for $2.50, you’re getting a *$4.99* smoothie for $2.50… and that can make all the difference in the world.

Add a little social norming, and Groupon does a great job of leveraging a couple of the powerful active ingredients of behavioral economics.